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Intercompany Indebtedness

Baker / Lembke / King. 8. Intercompany Indebtedness. Electronic Presentation by Douglas Cloud Pepperdine University. Bonds of Affiliate Purchased from a Non-affiliate. Acquisition of bonds of an affiliate by another consolidated entity: Constructive retirement

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Intercompany Indebtedness

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  1. Baker / Lembke / King 8 Intercompany Indebtedness Electronic Presentation by Douglas Cloud Pepperdine University

  2. Bonds of Affiliate Purchased from a Non-affiliate • Acquisition of bonds of an affiliate by another consolidated entity: Constructive retirement • If the acquisition value is the same with liability reported by debtor (at book value), the elimination is the same with direct inter-corporate debt transfer • Problems if purchase at other than book value (less than or more than book value)

  3. Bonds of Affiliate Purchased from a Nonaffiliate January 1, 20X1 Issuance of debt for Rp102,000,000 Purchase of debt by PT Induk for Rp91,000,000 on December 31, 20X1 8-10 PT Induk PT Anak PT Nonafiliasi Consolidated Entity

  4. Bond Liability Entries--20X1 PT Anak PT Anak Rp100,000,000 Rp100,000,000 On January 1, 20X1, PT Anak issues 10-year, 12 percent, semi annually bonds payable with a par value of Rp100,000,000; the bonds are issued at 102. The bonds are purchased from PT Anak by PT Nonafiliasi. Entry by PT Anak (15) Jan. 1 Cash 102,000,000 Bonds Payable 100,000,000 Premium on Bonds Payable 2,000,000 Sale of bonds to Nonaffiliated. PT Nonafiliasi PT Anak

  5. Bond Liability Entries--20X1 Rp100,000,000 x .12 x 6/12 Rp2,000,000 ÷ 20 interest periods Entries by PT Anak (16) June 30 Interest Expense 5,900,000 Premium on Bonds Payable 100,000 Cash 6,000,000 Semiannual payment of interest. (17)Dec. 31 Interest Expense 5,900,000 Premium on Bonds Payable 100,000 Cash 6,000,000 Semiannual payment of interest.

  6. Bond Investment Entry--20X1 Entries by PT Induk (18) Dec. 31 Investment in PT Anak Bonds 91,000,000 Cash 91,000,000 Purchase of PT Anak bonds from PT Nonafiliasi. This entry is the same as if the bonds purchased were those of an unrelated company.

  7. Constructive Debt Retirement-20X1 Book value of PT Anak’ bonds, December 31, 20X1 Rp101,800,000 Price paid by PT Induk to purchase bonds -91,000,000 Gain on constructive retirement of bonds Rp 10,800,000 Computation of Gain on Constructive Retirement Constructive gain or loss is assigned to the issuing company. It is shown only in consolidation process

  8. Basic Equity-Method Entries--20X1 Entries by PT Induk (20) Investment in PT Anak Bonds 40,000,000 Income from Subsidiary 40,000,000 Record equity-method income: Rp50,000,000 x .80 (19) Cash 24,000,000 Investment in PT Anak Stock 24,000,000 Record dividends from PT Anak: Rp30,000,000 x .80

  9. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income from Subsidiary 40,000 Dividends Declared (60,000 (30,000) Investment in PT Anak Stock 256,000 ) An entry is needed to eliminate the investment account during 20X1, the parent’s share of the subsidiary’s net income, and the dividends recognized during the year.

  10. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income from Subsidiary 40,000 40,000 Dividends Declared (60,000 (30,000) 24,000 Investment in PT Anak Stock 256,000 16,000 )

  11. Noncontrolling Interest’s Share of Income Net income of PT Anak Rp50,000,000 Gain on constructive retirement of bond 10,800,000 Realized net income of PT Anak Rp60,800,000 Noncontrolling stockholders’ share x .20 Noncontrolling interest’s share of income Rp12,160,000

  12. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income to Noncontrolling Interest Dividends Declared (60,000) (30,000) (21) 24,000 Noncontrolling Interest An entry is required eliminate the income from the subsidiary.

  13. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income to Noncontrolling Interest (22) 12,160 (12,160) Dividends Declared (60,000) (30,000) (21) 24,000 (22) 6,000 (60,000) Noncontrolling Interest (22) 6,160

  14. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Retained Earn- ings, Jan. 1 300,000 100,000 Investment in PT Anak Stock 256,000 (21) 16,000 Common Stock 500,000 200,000 Noncontrolling Interest (22) 6,160 An entry is necessary to eliminate PT Induk’s investment account and the stockholders’ equity balances of PT Anak at the beginning of the year, and establish the amount of the noncontrolling interest at the beginning of the year.

  15. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Retained Earn- ings, Jan. 1 300,000 100,000 (23)100,000 300,000 Investment in PT Anak Stock 256,000 (21) 16,000 (23) 240,000 Common Stock 500,000 200,000 (23)200,000500,000 Noncontrolling Interest 6,160 (23) 60,00066,160

  16. Consolidated Balances--20X1 ItemPT Induk PT Anak Unadjusted Consolidated Totals Amounts Bonds Payable -0- Rp(100,000,000) Rp(100,000,000) -0- Premium on Bonds Payable -0- (1,800,000) (1,800,000) -0- Investment in Bonds Rp91,000,000 -0- 91,000,000 -0- Interest Expense -0- Rp 11,800,000 Rp 11,800,000 Rp11,800,000 Interest Income -0- -0- -0- -0- Gain on Bond Retirement -0- -0- -0- (10,800,000)

  17. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Gain on Bond Retirement Investment in PT Anak Bonds 91,000 Bonds Payable 200,000 100,000 Premium on Bonds Payable 1,800 An entry is required to eliminate the intercompany bond holdings and recognize the gain on constructive retirement of the bonds.

  18. Constructive Debt Retirement--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Gain on Bond Retirement (24) 10,800 10,800 Investment in PT Anak Bonds 91,000 (24) 91,000 Bonds Payable 200,000 100,000 (24)100,000 200,000 Premium on Bonds Payable 1,800 (24) 1,800

  19. Consolidated Net Income--20X1 PT Induk’s separate operating income Rp140,000,000 PT Induk’s share of PT Anak’ income: PT Anak’ net income Rp50,000,000 Gain on constructive retirement of bonds 10,800,000 PT Anak’ realized income Rp60,800,000 PT Induk’s proportionate share x .80 48,640,000 Consolidated net income, 20X1 Rp188,640,000

  20. Noncontrolling Interest--20X1 Book value of PT Anak, December 31, 20X1: Common stock Rp200,000,000 Retained earnings 120,000,000 Total reported book value Rp320,000,000 Gain on constructive retirement of bonds 10,800,000 Realized book value of PT Anak Rp330,800,000 Noncontrolling stockholders’ share x .20 Noncontrolling interest, December 31, 20X1 Rp 66,160,000

  21. Bond Liability Entries--20X2 Rp100,000,000 x .12 x 6/12 Rp2,000,000 ÷ 20 interest periods Entries by PT Anak (25) June 30 Interest Expense 5,900,000 Premium on Bonds Payable 100,000 Cash 6,000,000 Semiannual payment of interest. (26)Dec. 31 Interest Expense 5,900,000 Premium on Bonds Payable 100,000 Cash 6,000,000 Semiannual payment of interest.

  22. Bond Investment Entry--20X2 Entries by PT Induk (27) June 30 Cash 6,000,000 Investment in PT Anak Bonds 500,000 Interest Income 6,500,000 . (28) Dec 31 Cash 6,000,000 Investment in SF Bonds 500,000 Interest Income 6,500,000 Record receipt of Bond Interest. Amortization of discount recorded per year: (Rp100,000,000 - Rp91,000,000) / 9 = Rp1,000,000. Per semester = Rp1,000,000 / 2 = Rp500,000

  23. Subsequent Recognition of Gain Bond premium Book value of bond liability Rp2,000,000 Rp1,800,000 Rp100,000,000 Bond discount Constructive gain of Rp10,800,000 Rp9,000,000 Carrying amount of bond investment Issue Maturity Purchase by affiliate

  24. Subsequent Recognition of Gain At Dec 20X1, Constructive Gain of Rp10,800,000 can be divided into: PT Induk’ discount on bond investment 9,000,000 PT Anak’s premium on bond liability 1,800,000 Total constructive gain on retirement 10,800,000 Subsequent recognition: PT Induk’discount amortization (9,000,000 / 9 years) 1,000,000 PT Anak’s premium amortization (1,800,000 / 9 years) 200,000 Annual increase each year 1,200,000

  25. Investment Account--20X2 Investment in PT Anak Stock Dividends (Rp30,000,000 x .80) 24,000,000 Original cost 240,000,000 20X1 Equity accrual (Rp50,000,000 x .80) 40,000,000 Balance, 12/31/X1 256,000,000 Equity accrual (Rp75,000,000 x .80) 60,000,000 Balance, 12/31/X2 284,000,000 Dividends (Rp40,000,000 x .80) 32,000,000

  26. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income from Subsidiary 60,000 Dividends Declared (60,000 (40,000) Investment in PT Anak Stock 284,000 ) An entry is needed to eliminate the investment account during 20X2, the parent’s share of the subsidiary’s net income, and the dividends recognized during the year.

  27. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income from Subsidiary 60,000 (31) 60,000 Dividends Declared (60,000 (40,000) (31) 32,000 Investment in PT Anak Stock 284,000 (31) 28,000 )

  28. Noncontrolling Interest’s Share of Income Net income of PT Anak Rp75,000,000 Less gain on constructive retirement of bond recognized in 2002: Amort. PT Induk’s Bond discount (1,000,000) Amort PT Anak’s Bond Premium (200,000) Realized net income of PT Anak Rp73,800,000 Noncontrolling stockholders’ share x .20 Noncontrolling interest’s share of income Rp14,760,000

  29. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income to Noncontrolling Interest Dividends Declared (60,000) (40,000) (31) 32,000 Noncontrolling Interest An entry is required eliminate the income from the subsidiary.

  30. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Income to Noncontrolling Interest (32) 14,760 (14,760) Dividends Declared (60,000) (40,000) (31) 32,000 (32) 8,000 (60,000) Noncontrolling Interest (32) 6,760

  31. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Retained Earn- ings, Jan. 1 420,000 120,000 Investment in PT Anak Stock 284,000 (21) 28,000 Common Stock 500,000 200,000 Noncontrolling Interest (32) 6,760 An entry is necessary to eliminate PT Induk’s investment account and the stockholders’ equity balances of PT Anak at the beginning of the year, and establish the amount of the noncontrolling interest at the beginning of the year.

  32. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Retained Earn- ings, Jan. 1 420,000 120,000 (33)120,000420,000 Investment in PT Anak Stock 284,000 (31) 28,000 (33) 256,000 Common Stock 500,000 200,000 (33)200,000 500,000 Noncontrolling Interest (32) 6,760 (33) 64,000

  33. Journal elimination no 34 – 20X2 Bonds Payable100,000,000 Premium on B/P 1,600,000 Interest Income 13,000,000 Investment in PT Anak Bonds 92,000,000 Interest Expense 11,800,000 R/E, Jan 1 8,640,000 Noncontrolling Interest 2,160,000

  34. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Interest Income 13,000 Interest Expense 20,000 11,800 Investment in PT Anak Bonds 92,000 Bonds Payable 200,000 100,000 Premium on Bonds Payable 1,600 Noncontrolling Interest (32) 6,760 (33) 4,000 An entry is required to eliminate intercompany holdings.

  35. Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated Retained Earn- ings, Jan. 1 420,000 120,000 (33)120,000 (34)8,640 428,640 Interest Income 13,000 (34) 13,000 Interest Expense 20,000 11,800 (34) 11,800 20,000 Investment in PT Anak Bonds 92,000 (34) 92,000 Bonds Payable 200,000 100,000 (34) 100,000 200,000 Premium on Bonds Payable 1,600 (34) 1,600 Noncontrolling Interest (32) 6,760 (33) 4,000 (34) 2,160 72,920

  36. Consolidated Net Income--20X2 PT Induk’s separate operating income Rp173,000,000 PT Induk’s share of PT Anak’ income: PT Anak’ net income Rp75,000,000 PT Induk’s amortization of bond discount - 1,000,000 PT Anak’ amortization of bond premium - 200,000 Income as a basis of apportionment Rp73,800,000 PT Induk’s proportionate share x .80 59,040,000 Consolidated net income, 20X2 Rp232,040,000

  37. Journal elimination for B/P – 20X3 Bonds Payable 100,000,000 Premium on B/P 1,400,000 Interest Income 13,000,000 Investment in PT Anak Bonds 93,000,000 Interest Expense 11,800,000 R/E, Jan 1 7,680,000 Noncontrolling Interest 1,920,000

  38. Purchase at Greater than Book Value • When an affiliate’s bonds are purchased from a nonaffiliate at an amount greater than their book value, a loss is recognized on the constructive retirement of the debt. • All other aspects of the consolidation process remain the same, that is, there are no other differences between constructive loss and a constructive gain.

  39. You Will Survive This Chapter !!! • The effects of intercompany debt transactions must be eliminated completely in preparing consolidated financial statements, just as with other types of intercompany transactions. • Only debt transactions between the consolidated entity and unaffiliated parties are reported in the consolidated statements.

  40. Chapter Eight The End

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